Tax changes help families paying for college

How the fiscal-cliff deal could ease the burden of college costs.

The fiscal-cliff deal Congress reached this week has one surprise winner: parents of college students.

In addition to extending the Bush-era tax cuts for all but the highest earners, the measure expands a college-related credit and several deductions that were scheduled to be scaled back or eliminated.

The changes come at a time when more families depend on education tax benefits to alleviate some of the burden of paying for college. Families received roughly $18.2 billion in such benefits for the 2011-12 academic year, compared with $7.3 billion in 2006-07 and $5.9 billion in 2001-02, according to the College Board. In many cases, the credit and deductions are available to families with relatively high incomes with phaseouts starting at around $130,000 for married couples filing jointly. These families typically have a tougher time qualifying for free aid, like need-based grants and scholarships.

But despite the more generous tax benefits, financial aid experts say college families can expect several hurdles in the weeks to come. It remains unclear whether drastic cuts to federal financial aid will kick in for the upcoming academic year. This issue has been held up by Congresss decision to delay talks over spending cuts for two more months. And its possible that the cuts that are implemented could outweigh this weeks improvements to the tax code, says Mark Kantrowitz, publisher of FinAid.org. I think it will be a real mess.

For now, here are four ways the fiscal-cliff deal will impact families of college students:

Tax credit

More than 9 million tax filers claimed the American Opportunity Tax Credit, receiving a total of $16 billion in benefits for tax year 2009, according to the latest data from the U.S. Government Accountability Office. The credit which can be claimed for expenses including tuition and fees was scheduled to shrink this year, but was instead extended through 2017.

As a result, families will be able to continue receiving a tax credit of up to $2,500 for each of the up to four years their child is in college. If Congress didnt include this provision in its newly passed bill, the credit would have dropped to a maximum of $1,900 a year for just two years of college education.

The credit has been extended to families with higher incomes as well. It begins to phase out at a modified adjusted gross income of $80,000 for single filers and at $160,000 for married couples filing jointly. Without the new provision, phaseouts would have begun at $50,000 and $100,000, respectively.

Tuition and fees deduction

For much of the past decade, families were able to deduct up to $4,000 in tuition and fees as an above-the-line exclusion from income. That tax benefit expired in 2011, but Congress brought it back for taxpayers for 2012 retroactively and for 2013.

The deduction is largely used by families trying to lower their tax bill, says Kantrowitz. It lowers their adjusted gross income, which could place them in a lower tax bracket or help them qualify for other credits they would have previously been locked out of. Still, taxpayers cant claim both the American Opportunity Tax Credit and the deduction for the same student in the same year theyll have to determine which one is more beneficial for them.

The deduction begins to phase out for single tax filers with adjusted gross incomes of $65,000 and at $130,000 for those married and filing jointly.

Student-loan interest deduction

Nine million tax filers claimed the student-loan interest deduction for tax year 2009, up from 8.1 million for tax year 2005, according to the GAO. As more families sign up for college loans, experts expect more tax filers to tap into this tax benefit.

Borrowers can now deduct up to $2,500 of interest they pay per year on private and federal loans for as long as they have the loans. If Congress had not passed the deal, they would only be able to claim this deduction for five years. The standard repayment period for federal loans is 10 years, according to FinAid.org.

The deduction starts to phase out at adjusted gross incomes of $60,000 for single filers and at $120,000 for married couples filing jointly.

Coverdell improvements made permanent

The new law also includes a provision that makes some temporary, user-friendly features of Coverdell Education Savings Accounts tax-advantaged investment accounts used for education purposes permanent. That includes extending the $2,000 annual contribution limit and allowing families to use this vehicle to save for elementary and secondary school expenses not just college. These features were scheduled to expire this year, which would have lowered the maximum annual contribution limit to $500 and restricted Coverdells just to college expenses.

Still, it remains to be seen whether this change will encourage more families to use this account. Less than 3% of families saved in a Coverdell or a 529 plan in 2010, according to a study released by the GAO in December 2012. The new provision allows more families to save with a Coverdell by extending the higher phase-out limits, which start at $190,000 for married couples filing jointly; they were previously scheduled to drop to $150,000. Phaseouts for single filers remain the same, starting at $95,000.